An apocalyptic mood has seized the highest levels of global capital as the global financial system continues to implode. This implosion is but the latest financial crisis to wrack global capitalism. Financial crises are inevitable since capitalist growth has increasingly been driven by speculative bubbles such as the housing bubble in the United States. The increasingly uncontrolled financial gyrations stem from the increasing divergence between an expansive financial economy and a stagnant real economy. This ?disconnect? stems from the persistent stagnationist trends in the real economy owing to overproduction or overcapacity. The search for profitability is capitalism?s driving force, and increasingly, significant profits can only be obtained from financial speculation rather than investment in industry. This is, however, a volatile and unstable process since the divergence between momentary financial indicators like stock and real estate prices and real values can proceed only up to a point before reality bites back and enforces a ?correction.? The bursting of the US housing bubble is one such correction, and it is leading not only to a recession in the US but to a global recession owing to the unprecedented level of integration fostered by corporate-led globalization. It will not be easy to restore dynamism by fostering another speculative bubble, for instance, by resorting to ?Military Keynesianism.?
?We have to pay for the sins of the past.? -- Klaus Schwab, key organizer of the Davos elite jamboree
SAN FRANCISCO -- Skyrocketing oil prices, a falling dollar, and collapsing financial markets are the key ingredients in an economic brew that could end up in more than just an ordinary recession. The falling dollar and rising oil prices have been rattling the global economy for sometime, but it is the dramatic implosion of financial markets that is driving the financial elite to panic.
And panic there is. Even as it characterized Federal Reserve Board Chairman Ben Bernanke?s deep cuts amounting to a 1.25 percentage points off the prime rate in late January as a sign of panic, The Economist admitted that ?there is no doubt that this is a frightening moment.? The losses stemming from bad securities tied up with defaulted mortgage loans by ?subprime? borrowers are now estimated to be in the range of about $400 billion, but, as the Financial Times warned, ?the big question is what else is out there? at a time that the global financial system ?is wide open to a catastrophic failure.?
What is ?out there? is suggested by the fact that it has been only in the past few weeks that a series of Swiss, Japanese, and Korean banks have owned up to billions of dollars in subprime-related losses. The globalization of finance was, from the beginning, the cutting edge of the globalization process, and it was always an illusion to think that the subprime crisis could be confined to US financial institutions, as some analysts had thought.
Some key movers and shakers sounded less panicky than resigned to some sort of apocalypse. At the global elite?s annual weeklong party at Davos in late January, George Soros sounded positively necrological, declaring to one and all that the world was witnessing ?the end of an era.?
World Economic Forum host Klaus Schwab spoke of capitalism getting its just desserts, saying, ?We have to pay for the sins of the past.? ?It?s not that the pendulum is now swinging back to Marxist socialism,? he told the press, ?but people are asking themselves, ?What are the boundaries of the capitalist system?? They think the market may not always be the best mechanism for providing solutions.?
Ruined reputations and policy failures
While some appear to have lost their nerve, others have seen the financial collapse diminish their stature.
As chairman of President?s Bush?s Council of Economic Advisers in 2005, Ben Bernanke attributed the rise in US housing prices to ?strong economic fundamentals? instead of speculative activity, so is it any wonder, ask critics, why, as Fed chairman, he failed to anticipate the housing market?s collapse stemming from the subprime mortgage crisis?
His predecessor, Alan Greenspan, however, has suffered a bigger hit, moving from iconic status to villain of the piece in the eyes of some. They blame the bubble on his aggressively cutting the prime rate to get the US out of recession in 2003 and restraining it at low levels for over a year. Others say he ignored warnings about aggressive and unscrupulous mortgage originators enticing ?subprime? borrowers with mortgage deals they could never afford.
The scrutiny of Greenspan?s record and the failure of Bernanke?s rate cuts so far to reignite bank lending has raised serious doubts about the effectiveness of monetary policy in warding off a recession that is now seen as all but inevitable. Nor will fiscal policy or putting money into the hands of consumers do the trick, according to some weighty voices.
The $156-billion stimulus package recently approved by the White House and US Congress consists largely of tax rebates, and most of these, says New York Times columnist Paul Krugman, will go to those who don?t really need it. The tendency will thus be to save rather than spend the rebates in a period of uncertainty, defeating their purpose of stimulating the economy.
The specter that now haunts the US economy is Japan?s experience of virtually zero growth per annum and deflation in the nineties and early part of this decade despite one stimulus package after another after Tokyo?s great housing bubble deflated in the late 1980s.
The inevitable bubble
Even as the finger-pointing is in progress, many analysts remind us that if anything, the housing crisis should have been expected all along. The only question was when it would break. As progressive economist Dean Baker of the Center for Economic Policy Research noted in an analysis several years ago, ?Like the stock bubble, the housing bubble will burst. Eventually, it must. When it does, the economy will be thrown into a severe recession, and tens of millions of homeowners, who never imagined that house prices could fall, likely will face serious hardship.?
The subprime mortgage crisis was not a case of supply outrunning real demand. The ?demand? was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that flooded the US in the last decade. Big-ticket mortgages were aggressively sold to millions who could not normally afford them by offering low ?teaser? interest rates that would later be readjusted to jack up payments from the new homeowners.
These assets were then ?securitized? with other assets into complex derivative products called ?collateralized debt obligations? by the mortgage originators working with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors.
The shooting up of interest rates triggered a wave of defaults and many of the big name banks and investors-- including Merrill Lynch, Citigroup, and Wells Fargo--found themselves with billions of dollars worth of bad assets that had been given the green light by their risk assessment systems.
The failure of self-regulation
The housing bubble is but the latest of some 100 financial crises that have swiftly followed one another ever since Depression-era capital controls began being lifted at the onset of the neoliberal era in the early 1980s. The calls now coming from some quarters for curbs on speculative capital have an air of déjà vu to many observers.
After the Asian Financial Crisis of 1997, in particular, there was a strong clamor for capital controls, for a ?new global financial architecture.? The more radical of these called for currency transactions taxes such as the famed Tobin Tax that would slow down capital movements or for the creation of some kind of global financial authority that would, among other things, regulate relations between northern creditors and indebted developing countries.
Global finance capital, however, resisted any return to state regulation. Nothing came of the proposals for Tobin taxes. Even a relatively weak ?sovereign debt restructuring mechanism? akin to the US Chapter 11 to provide some maneuvering room to developing countries undergoing debt repayment problems was killed by the banks despite its being proposed by Ann Krueger, the conservative American deputy managing director of the IMF.
Instead, finance capital promoted what came to be known as the Basel II process, described by political economist Robert Wade as steps toward global economic standardization that ?maximize [global financial firms?] freedom of geographical and sectoral maneuver while setting collective constraints on their competitive strategies.?
The emphasis was on private sector self surveillance and self policing aiming at greater transparency of financial operations and new standards for capital. Despite the fact that it was Northern finance capital that triggered the Asian crisis, the Basel process focused on making developing country financial institutions and processes transparent and standardized along the lines of what Wade calls the ?Anglo-American? financial model.
While there were calls for regulation of the proliferation of many of the new, sophisticated financial instruments such as derivatives being placed on the market by developed country financial institutions, these got nowhere. Assessment and regulation of derivatives were to be left to market players who had access to sophisticated quantitative ?risk assessment? models that were being developed.
Focused on disciplining developing countries, the Basel II process accomplished so little in the way of self regulation of global financial from the North that even Wall Streeter Robert Rubin, formerly secretary of state under President Bill Clinton, warned in 2003 that ?future financial crises are almost surely inevitable and could be even more severe.?
As for risk assessment of derivatives such as the ?collaterized debt obligations? (CDOs) and ?structured investment vehicles? (SIVs) -- the cutting edge of what the Financial Times has described as ?the vastly increased complexity of hyperfinance? --the process collapsed almost completely, with the most sophisticated quantitative risk models left in the dust as risk was priced according to one rule by the sellers of securities: Underestimate the real risk and pass it on to the suckers down the line.
In the end, it was difficult to distinguish what was fraudulent, what was poor judgment, what was plain foolish, and what was out of anybody?s control. As one report on the conclusions of a recent meeting of the Group of Seven?s Financial Stability Forum put it:
[T]here is plenty of blame to go around for the financial chaos: The US subprime mortgage market was marked by poor underwriting standards and ?some fraudulent practices.? Investors didn?t carry out sufficient due diligence when they bought mortgage-backed securities. Banks and other firms managed their financial risks poorly and failed to disclose to the public the dangers on and off their balance sheets. Credit-rating companies did an inadequate job of evaluating the risk of complex securities. And the financial institutions compensated their employees in ways that encouraged excessive risk-taking and insufficient regard to long-term risks.
The specter of overproduction
It is not surprising that the Group of Seven report sounded very much like the post-mortems of the Asian financial crisis and the dot.com bubble. One chieftain of a financial corporation chief writing in the Financial Times captured the basic problem running through these speculative manias, perhaps unwittingly, when he claimed that ?there has been an increasing disconnection between the real and financial economies in the past few years. The real economy has grown ? but nothing like that of the financial economy, which grew even more rapidly -- until it imploded.?
What his statement does not tell us is that the disconnect between the real and the financial is not accidental, that the financial economy expanded precisely to make up for the stagnation of the real economy.
This growing gap between the financial and the real cannot be comprehensively understood without referring to the crisis of overaccumulation that overtook the center economies in the late 1970s and 1980s, a phenomenon that is also referred to as overproduction or overcapacity.
The golden period of postwar growth globally that skirted major crises for nearly 25 years was due to the massive creation of effective demand via rising wages for labor in the North, the reconstruction of Europe and Japan, and the import-substituting industrialization in Latin America and other parts of the South. This was done principally via state intervention in the economy.
This dynamic period came to a close in the mid-1970s, with stagnation setting in, owing to global productive capacity outrunning global demand, which was constrained by continuing deep inequalities in income distribution.
According to the calculations of Angus Maddison, the premier expert on historical statistical trends, the annual rate of growth of global gross domestic product (GDP) fell from 4.9 percent in what is now regarded as the golden age of the post-World War II Bretton Woods system, 1950-73, to 3.0 percent in 1973-89, a drop of 39 percent. These figures reflected the wrenching combination of stagnation and inflation in the North, the crisis of import substitution industrialization in the South, and erosion of profit margins all around.
In the 1980s and 1990s, global capital blazed three escape routes from the specter of stagnation. One was neoliberal restructuring, which included redistribution of income towards the top via tax cuts for the rich, deregulation, and an assault on organized labor. Neoliberalism took the form of Thatcherism and Reaganism in the developed North and World Bank and International Monetary Fund (IMF)-imposed structural adjustment in the global South.
Another was corporate-driven globalization or ?extensive accumulation,? which opened up markets in the developing world and moved capital from high-wage to low-wage areas. As Rosa Luxemburg long ago pointed out in her classic ?The Accumulation of Capital,? capital needs to constantly integrate pre-capitalist societies to the capitalist system to shore up the fall in the rate of profit.
In the past two decades, the most spectacular case of incorporating a pre-capitalist society into the global capitalist system was China, which became both the world?s second biggest exporter and the primary destination of foreign investment. This was, however, a double edged sword for capitalism, as we shall later see.
A third was the process we are mainly concerned with here: ?intensive accumulation? or ?financialization,? that is, the channeling of investment towards financial speculation, where much greater returns were to be derived than in industry, where profits were largely stagnant. Finance capital forced the elimination of capital controls, the result being the rapid globalization of speculative capital to take advantage of differentials in interest and foreign exchange rates in different capital markets.
These volatile movements, the result of capital?s liberation from the fetters of the postwar Bretton Woods financial system, were one source of instability. Another was the proliferation of novel sophisticated speculative instruments like derivatives that escaped monitoring and regulation. Instability derived ultimately from the fact that speculative finance boiled down to an effort to squeeze more ?value? out of already created value instead of creating new value since the latter option was precluded by the problem of overproduction in the real economy.
The disconnect between the real economy and the virtual economy of finance was evident in dot.com bubble of the 1990s. With profits in the real economy stagnating, the smart money flocked to the financial sector. The workings of this virtual economy were exemplified by the rapid rise in the stock values of Internet firms, which, like Amazon.com, still had to turn a profit. The dot.com phenomenon probably extended the boom of the 1990s by about two years.
?Never before in US history,? Robert Brenner wrote, ?had the stock market played such a direct, and decisive, role in financing non-financial corporations, thereby powering the growth of capital expenditures and in this way the real economy. Never before had a US economic expansion become so dependent upon the stock market?s ascent.?
But the divergence between momentary financial indicators like stock prices and real values could only proceed to a point before reality bit back and enforced a ?correction.? And the correction came savagely in the dot.com collapse of 2002, in the form of the wiping out of $7 trillion in investor wealth.
A long recession was avoided, but it was only by encouraging another bubble, the housing bubble, and here, as noted earlier, Greenspan played a key role by cutting the prime rate to a 45-year low of 1.00 percent in June 2003, holding it there for a year, then raising it only gradually, in quarter-percentage-increments. As Dean Baker put it, ?an unprecedented run-up in the stock market propelled the US economy in the late nineties and now an unprecedented run-up in house prices is propelling the current recovery.?
The result was that real estate prices rose by 50 percent in real terms, with the run-ups, according to Baker, being close to 80 percent in the key bubble areas of the West Coast, the East Coast, North of Washington DC, and Florida. How big was the bubble created? It is estimated by Baker that the run-up in house prices ?created more than $5 trillion in real estate wealth compared to a scenario where prices follow their normal trend growth path. The wealth effect from house prices is conventionally estimated at five cents to the dollar, which means that annual consumption is approximately $250 billion (2.0 percent of GDP) higher than it would be in the absence of the housing bubble.?
To be continued on Thursday